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Cryptocurrency – How it works and why do we use it?

Rohan Shrestha

Senior Mobile Developer

A cryptocurrency (or crypto currency) is a digital asset designed to work as a medium of exchange that uses cryptography to secure its transactions, to control the creation of additional units, and to verify the transfer of assets. Cryptocurrencies are a type of digital currencies that use decentralized control, meaning it is controlled by users with computer algorithm not a central government as opposed to central banking systems. The decentralized control of each cryptocurrency works through a blockchain, which is a public transaction database, functioning as a distributed ledger.

The first cryptocurrency was Bitcoin which was created in 2009 and is still the best known. Since then numerous other cryptocurrencies have been created. Ethereum, Ripple, Litecoin are some other cryptocurrencies.

How it works?

To understand how a cryptocurrency works, we will need to learn few basic concepts specifically:

Public Ledgers: All confirmed transactions from the start of a cryptocurrency’s creation are stored in a public ledger. The identities of the coin owners are encrypted, and the system uses other cryptographic techniques to ensure the legitimacy of record keeping. The ledger ensures that corresponding “digital wallets” can calculate an accurate spendable balance. Also, new transactions can be checked to ensure that each transaction uses only coins currently owned by the spender. Bitcoin calls this public ledger a blockchain.

Transactions: A transfer of funds between two digital wallets is called a transaction. That transaction gets submitted to a public ledger and awaits confirmation. When a transaction is made, wallets use an encrypted electronic signature (an encrypted piece of data called a cryptographic signature) to provide a mathematical proof that the transaction is coming from the owner of the wallet. The confirmation process takes a bit of time (ten minutes for bitcoin) while “miners” mine. Mining confirms the transactions and adds them to the public ledger.

Mining: In a simple term, mining is the process of confirming transactions and adding them to a public ledger. To add a transaction to the ledger, the miner must solve an increasingly-complex computational problem. Mining is open source so that anyone can confirm the transaction. The first miner to solve the puzzle adds a block of transactions to the ledger. The way in which transactions, blocks, and the public blockchain ledger work together ensure that no one individual can easily add or change a block at will. Once a block is added to the ledger, all correlating transactions are permanent, and they add a small transaction fee to the miner’s wallet (along with newly created coins). The mining process is what gives value to the coins.

Benefits of using cryptocurrency:

1. Send Money to anyone anywhere in the world, almost instantly, with no middle hand or excessive fees.

2. Include everyone in the financial system, not only the people who have access to modern day banking.

3. Track every transaction with complete transparency.

4. The possibility to build on top and around the block chain to fundamentally change the way we use and interact with money.

5. Cryptocurrencies are digital and cannot be counterfeited or reversed arbitrarily by the sender, as with credit card charge-backs.